Sunday, August 9, 2009

The True State of the Real Estate Market

My favorite mainstream-insider economist, Martin Feldstein is out with a new Op-Ed in WSJ. WSJ is running it on a weekend (Its lowest circulation day), so that may tell you something about WSJ, but here's Feldstein breaking down the current real estate data:

An epidemic of mortgage defaults and foreclosures is threatening the economic recovery. The problem is serious and getting worse. More than three million homes are now in serious default (nonpayment for 90 days or more) or foreclosure, nearly double the number a year ago. Sales of properties in foreclosure or serious default made up one third of all home sales in May and June.

Despite a slight uptick in house prices in some markets recently, the sales of foreclosed properties continue to dampen house prices and weaken banks’ balance sheets. The uncertain pace of future losses makes banks nervous about the adequacy of their capital, which discourages bank lending and economic growth.

There are two separate but mutually reinforcing reasons for the surge in defaults and foreclosures: the reduced affordability of mortgage payments and the high loan-to-value ratios of many houses.

The affordability problem is the familiar one. Many homeowners become unable to make their payments when they lose their job or have to accept part-time work. Others are unable to cope with the increase in monthly payments that occurs when the interest rates on their adjustable-rate mortgages automatically reset.

The Obama administration is trying to fix the affordability problem by sharing with banks and other creditors the cost of reducing monthly payments to 31% of household income. So far only about 200,000 mortgages have been modified this way, far fewer than the administration’s goal of modifying three million mortgages.

More importantly, experience with such mortgage modifications by the FDIC is not promising: Nearly half of all modified mortgages go into default within six months. That’s partly because, even when they can afford the reduced mortgage payments, many homeowners default anyway because they owe more on the house than it is worth. Thanks to this “negative equity,” they just walk away.

These defaults happen because in the United States, unlike almost every other country, mortgages are effectively no-recourse loans. If a homeowner defaults, the creditor can take the house but is unable to take other assets or income to make good on the remaining unpaid mortgage balance.

In some states creditors have the legal right to pursue other assets or income. But personal bankruptcy rules limiting what they can take give them little incentive to do so. No-recourse mortgages increase foreclosures, resulting in more properties being thrown on the market, and lead to an excess decline in house prices.
From there Feldstein takes the column into a policy prescription that involves more monkeying and setting of regulations by government, instead of just proposing that the free market should be allowed to develop its own mortgage finance rules. But, hey I warned you, he's an insider---but his factual analysis is right on.

The rest of Feldstein's op-ed is here.

No comments:

Post a Comment